Strong Growth Abroad Lifts Priceline's Results

Priceline delivered solid top line and bottom line growth in Q2 2014. Revenues increased 26% year over year to $2.12 billion, helped by a 34% rise in gross bookings. The growth was broad-based with an increase of 29% in hotel room nights, 14% in rental car days and 22% in airline ticket volumes. The advertising division also posted strong growth with revenues rising by 130% to $82 million due to the acquisition of Kayak. The effects of the solid revenue growth also trickled down to the bottom line. The company's net income for the quarter stood at $576 million, 32% higher compared to the year ago period.

International Business Will Continue to Fuel Growth In Bookings

Priceline's growth in recent years has come from its expansion initiatives in international markets, primarily Europe. The company bought out the online travel agency Booking.com in 2005, which grew to become the market leader in Europe with over 30% share in 2012. Priceline is now aggressively targeting high-growth international regions such as South America and Asia-Pacific. This helped the company to register 36% year-on-year growth in international gross bookings in Q2 2014.

Booking.com's dominance over the core European market also contributed significantly to the results. Booking.com is the leading OTA in Europe with 31% share of the market. The brand is expanding its presence in Australia, Canada, Germany and the U.K. through its Booking.yeah advertising campaign. It also increased its hotel supply by 58% in Q2 2014, to end the quarter with an inventory of 525,000 hotels and accommodations in 205 countries. We believe that international markets will continue to be the primary growth driver for Priceline in the near future.

Operating Margins Could Face Pressure

Priceline delivered a 150 basis points expansion in operating margins in Q2 owing to advertising and operational efficiencies. Advertising efficiencies resulted from the acquisition of Kayak, a company that spends less on online and more on offline advertising; ROI (return on investment) on online advertising is lower than on offline advertising. Further, the amount spent by Priceline's brands for ad placements on Kayak is eliminated from the consolidated results.

We believe that Priceline will not be able to substantially grow its margins in the future due to increasing competition in the OTA space, falling returns on investments on online advertising and the anniversary of Kayak's acquisition on May 21 this year. Additionally, the company is aggressively spending on offline advertising campaigns for its Booking.com brand in Canada, Germany, Australia, the U.S. and the U.K. It expects to incur between $130 million on offline advertising expense in 2014, with more than half the estimated expenditure expected to occur in Q3. This will put increased pressure on margins.